China PE incentives: End of the party

Futian district, a Shenzhen transportation hub that serves as a conduit with Hong Kong, wants private equity investors to help drive growth and it is willing to pay for the privilege. Locally registered GPs can expect to receive government subsidies of up to RMB30 million ($4.3 million) on property purchases or advances of RMB10 million to cover rental costs. In addition, any manager that contributes at least RMB10 million in tax revenue may receive up to RMB10 million in credit the following year.

The measures are generous – the property subsidies are 6-10 times higher than those provided by the Shenzhen municipal authorities to PE funds – but until recently they wouldn’t have been considered unusual. As a central government-led effort to clean up the domestic private equity intensifies, however, Futian appears to be one of the last localities offering these kinds of incentives.

Indeed, a Futian government representative confirmed the policies to AVCJ, adding that they only applied to existing GPs relocating to the district, not newly launched managers. This is perhaps just as well. Shenzhen is no longer approving new registrations.

“Many local administrations could not raise capital for projects through bonds because issuance was curbed as part of Beijing’s delivering efforts, so some pinned their hopes on investment brought in by private equity,” says Tai-leung Chong, an associate professor of economics at the Chinese University of Hong Kong. These ambitions are unlikely to be realized. Chong notes that the level of scrutiny directed at PE firms is now so intense that preferential policies of old are difficult to maintain.

Poster child

Six years ago, local governments treated private equity as a poster child for inbound investment. They were supposed to catalyze emerging industries, creating a halo effect that would draw in more corporate capital. For instance, the remote autonomous regions of Tibet and Xinjiang recognized that few investors would come and do business there without sufficient encouragement.

Incentives usually came in two forms: waiving income taxes and one-off payments for locating in a certain city. The level of generosity varied considerably between localities. In 2005, Beijing issued a notice granting one-off settlement fees of RMB10 million to PE firms with assets under management (AUM) in excess of than RMB1 billion and RMB8 million for those with at least RMB500 million. Shanghai introduced a similar policy in 2011, promising rewards of RMB1-15 million to GPs that set up in the city.

Perhaps most eye-catching were the so-called fund towns, typically located in quiet suburbs. Local authorities offered substantial tax breaks and enticement not unlike those promoted by Futian. As of year-end 2017, China had 45 fund towns scattered across southern provinces, notably Zhejiang. They were described as the country’s answer to Greenwich Village by local media.

The consequent change in attitude has been gradual and spurred by a combination of factors. A 2014 notice by the State Council asking local governments to refrain from granting preferential policies including tax breaks to private equity firms and other companies could have been a trigger point. It warned that these policies would cause “disruption to the market order and prompt more monopolies.”

Moreover, from 2016 onwards, Beijing has become increasingly wary of the economic risks posed by overleverage. Private equity has been caught up in this largely through steps taken to curtail illegal fundraising practices. Managers must meet strict registration, disclosure and compliance criteria, and face expulsion from the industry if they fall short.

At the same time, controlling rising local government debt levels is a key part of the central government’s deleveraging campaign. A recently announced plan to merge the State Administration of Taxation (SAT) with provincial and municipal-level bureaus underlines the desire to impose tighter controls on local finance. As a result, there is now less money to spend on incentives for private equity.

“Previously, the investment promotion arms of some bureaus would write down the preferential policies or tax breaks to investors in contracts or other documents that they would sign. However, they would not do so anymore in a bid to play safe under the tighter scrutiny,” says Candy Tang, a partner at Fangda Partners. She adds that these incentives are often not renewed when they expire, while there is great reluctance to roll out new ones.

Closing the door

Tianjin is said to have been one of the first local authorities to stop offering preferential policies, having taken a decision four or five years ago. Since then, the crackdown has extended even further. Raising capital through formal channels is contingent on registration with the local Administration for Industry & Commerce (AIC), which in turn requires an approval certificate from the local Ministry of Finance (MoF). According to Dayi Sun, a managing partner at Jade Invest, the approvals process drags on interminably unless a GP is backed by prominent state-owned investors or large listed companies.

“Most of the incentive initiatives offered by local governments have been canceled or suspended because the central government wants to control the number of private equity firms in China,” Sun says. “As a result, in the past two years, registering new funds has already become extremely difficult, let alone getting preferential policies.”

A representative of the AIC in Tianjin’s Heping district told AVCJ that registrations for new funds stopped a while ago. He didn’t know when they would resume. Zhejiang is still open for business, but managers must go through a series of interviews with the principal MoF. Beijing and Shanghai have also started to make it harder for new funds to register, according to the local AICs.

The fund town boom has come to an abrupt halt as well. Chinese media reports claim that only 6.7% of the 45 are completed, 13% have yet to begin construction, and another 13% are no longer offering any information on their current status.

Meanwhile, local authorities have generally become more compliant. Three years ago, an SAT request that preferential tax policies be cleaned up because they are inconsistent with tax law or national policies would have met with different levels of responsiveness, based on a locality’s own incentives and its assessment of the rule on the context of the current political environment. “In some cases, the notice was vacated just a few months later,” says James Wang, investment funds partner at Han Kun Law Offices. “But it’s quite a different macro and regulatory environment this time around.”

There have been some attempts to push back. For instance, a Guangdong-based GP says the local private equity association is in talks with AIC to end a ban on new registrations that came into force in August. It remains to be seen what impact these lobbying efforts might have.

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• Topics
• Greater China
• Fundraising
• Regulation
• Renminbi fund
• China